I am a registered investment advisor based in Houston Texas, specializing in equity options. My focus is naked put selling and spread trading. I have past experience in commercial banking, real estate, and oil and gas, as well as various types of other derivative investments. My world was turned upside down by the financial crisis of 2008-9. Many of my views are slanted to expose and correct the corruptions existing in the world’s financial markets. I have a BS in economics from UC Berkeley and an MBA in finance from the U of Pennsylvania Wharton School. Reach me at rbf10@comcast.net

Meet The New Subprime: It Will Cost Us Billions

When will our government come to realize that not everyone in this country can own a home? Not an issue of cruelty or insensitivity or lack of dream for Utopia, but a simple matter of economics. Not everyone has 20% or even 10% to make a bona fide down payment and have the subsequent income to comfortably service the debt. Apparently the continuing pain of the subprime crisis has taught our feckless politicians nothing. While sub-prime has morphed into a naughty word, a near clone has stealthily infiltrated the mortgage markets, choking the breath out of many unfortunates ensnared by its enervating tentacles. Meet the Federal Housing Administration or FHA. It found life under Roosevelt in 1934 as part of his alphabet soup answer to extricate America from depression. It started as a benign institution, and like today, insured loans and offered some down payment relief to borrowers.

Why Has FHA Become A Monster Now

Last November the Department of Housing and Urban Development (HUD) under whose purview FHA falls, issued the September 30 fiscal year 2011 annual report. It was a rather damning indictment. Capital which is statutorily set at 2% of assets had fallen to a measly .24% or from $4.7 billion in 2010 to $2.6 billion in year end 2011. It is only a mere $20 billion shy of requirement. This capital is expressed as the MMI or Mutual Mortgage Insurance Fund or the backstop to any defaults on the $1.1 trillion of FHA insured loans outstanding. The auditors estimated $26 billion of losses for loans underwritten through the first quarter of 2009 and another $14.1 billion for “seller funded down payment assistance loans”. Though since curtailed, the seller used to be able to loan the purchaser most or all of the down payment leaving the buyer with little or no “skin in the game.” Then the auditors sang the praises that the 2010 and 2011 books of business will be profitable, and put new risk guidelines and credit policies in place so all is well and they expect to be in capital compliance by 2015.

A large part of the problem is that to qualify for a mortgage at FHA you need little more than an active “pulse”. Requirements have been repeatedly watered down. The down payment requirements are 3.5% with a credit score of 580. A score below 640 is considered subprime by the Federal Reserve. When you roll in the insurance fee into the loan balance you have a loan to value ratio that starts at over 98%. The paltry down payment may be funded by relatives or employers. It gets more bizarre. Borrowers can claim income from a roommate (to be found at a later date) to help qualify for the loan. Often no cash reserves are required to demonstrate ability handle repair bills and taxes and still meet mortgage obligations. In addition, when you default you just go and apply to the pernicious Home Affordable Modification Program or HAMP which is designed to give our beleaguered mortgagor several more bites at the apple. His or her loan will be modified (interest rate reduced or principal forgiven) and because of new more lenient HAMP rules, when she or he defaults again, the loan can be rejiggered yet one more time. All the income requirements at HAMP have been reduced more than once. HAMP also has one of those goofy phantom roommate clauses.

The contrast between FHA and Fannie Mae tells the story. First Fannie Mae issues what are known as conforming or “conventional” loans which have such requirements as 20% money down and cash reserves for repairs as well as infinitely stricter income requirements than FHA. Second, and insidiously, FHA now has a loan limit that is higher than Fannie Mae. Ex Alaska and Hawaii, FHA has loan limits up to $729,750 while conventional mortgages are stuck at $625,000. So in effect there has been a “disintermediation” away from Fannie and into FHA. If you have little cash the lax requirements of FHA is the siren call. This is borne out as FHA has increased threefold in size since 2005. And combined with HAMP a borrower has multiple opportunities to default with impunity, the system encourages irresponsible behavior.

Realizing that perhaps this Ponzi scheme can’t endure indefinitely, FHA has raised their insurance premiums to borrowers twice this year, most recently with Congress giving, with a 402-7 vote, it’s imprimatur on the FHA Fiscal Solvency Act which raised cost of insurance to up to 2.05% annually. The bill announced more hollow risk guidelines and even hired a new risk officer to make sure all roommates are in compliance. HUD Secretary Donovan emerged from his cave and hailed this would ensure the solvency of FHA.

Meanwhile, economists at the Federal Reserve were crunching some numbers of there own. FHA has for years underestimated their losses from claims on defaulted loans. It turns out that every time FHA has a loan default but it gets modified into a new loan, then this loan is a success and hence not counted as a defaulted loan. In fact, this default is a default and not a success and to the extent it has been modified (lower interest or principal) it cost me and you the taxpayer, money. Additionally, it was discovered that 49% of all reworked loans defaulted a second time within twelve months. The bottom line is FHA uses a faulty econometric model that vastly underestimates defaults to forecast losses. The Fed, which used actual FHA loan data from 2007-2009, predicts there will be a 30% default rate on these loans within five years.

Some Mind Blowing Statistics

So on the one side of the aisle sits HUD secretary Donavan pontificating all is well in FHA land, while on the debit side of the ledger the Federal Reserve has produced a significantly less sanguine vision for the future. Skeptic that I am, I tend to believe half of what I see first hand. Ergo, I embarked on a little sleuthing mission to compare the credibility of each stance. Locating the latest 10Q’s (second quarter 2012) for JPM, BAC, and WFC, I combed the nether intestines in search of their FHA loan exposures and what is the current delinquency experience. Sobering understates the resulting data. BAC, far and away the largest FHA lender of the three has a $67.3 billion book of which $18.1 billion or 26.9% is 90 days or more past due. It gets worse. Government guaranteed loans at WFC total $28.43 billion and a whopping 69.3% fall into the 90 day overdue basket. JPM brings up the rear with a comparatively small $15.9 billion but with an incredible 74.8% being derelict by three months or more. When you add up these three lenders you arrive just under $112 billion or 10% of the total $1.1 trillion FHA insured market. Take my word, in aggregate the math and division yields that nearly 45% of all of these FHA insured loans are three payments or more behind. That is $49.5 billion of loans more than three moths past due. The FHA has $2.6 billion in capital. Can we extrapolate to the other 90% of the market? Who knows, but these three banks have operations covering areas in excess of 95% of the population of America.

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Yes, lcr1946, the people involved were expoited because of their ignorance. Their belief, fraudulently reinforced by the bank, was that the bank was representing their interests instead of its own. The banks then created poor quality loan assets but which contained implied or explicit federal guarantees. The banks then repapered and sold the loans at a price inflated by those guarantees (at least the smart ones did). The net effect is that the banks wind up with the federal money, the purchasers get junk paper, and when it implodes the lawyers jump in — and the taxpayers get the bill.

BUT – the enabler was the federal involvement, which created a gravy train of sleaze.

Oh, yeah — the housing model was so attractive the feds applied it to student loans. There are a couple of twists, like no discharge of the loans in bankruptcy and predatory rate hikes on delinquency, virtually creating a class of slaves who thought they were getting an education. Of course they probably didn’t get that either since the universities don’t have to answer for the value of the curriculum.

Can you imagine a business that gets a customer to pay $60,000/yr for the chance to work for four to six years in order to receive something worthless (e.g. BA in philosophy)? The gov. thinks it’s such a great idea that they will loan you big money to get it. At least they aren’t letting you cheat the system that cheated you – enter Sallie Mae, an off-the-books federal loanshark that can own you for decades with tactics only a little better than the mob. At least the repackaged loans will sell high. And the public goes on American dreaming, this time about a university education.

Gotta give it to Congress, when it comes to making an unscrupulous, exploitive business, they were efficient and effective.

What is the idea of everybody but me is on the government dole. The numbers you folks quote are incorrect. If you’ll be fair enough about it, none of you solid citizens blaming everybody else for the country’s woes have bothered to blame the people who knew there was a problem. The very same ones that you now support in castigating the victims of a massive fraud.

While you folks think everything is some kind of conspiracy to deprive you of something, I see it as a conspiracy to commit fraud. How about a discussion of fiduciary responsibility, or can we just agree it doesn’t exist any more. Also please explain how this attack on people victimized by fraud and irresponsible, unethical business behavior has anything to do with calling out boardroom folly. You’ve blamed everybody but those in the boardroom.

This whole “take responsibility for oneself” bull is nothing more than a campaign to blame the people who got screwed rather than blame the greedy bastards that perpertrated this crime on society.

This whole refrain is becoming a lot like a superior minority thinks they are carrying the rest of the country and the rest of us should acknowledge your superiorty. Let me say the ideas that business should be unfettered to do what they want and the rest of us make do as best we can is not American and your efforts to blame the victims are starting to earn points, negative points.

How about putting some reality into your thinking. there have been no proposals for fixing problems even though correcting market imbalances and instituting regulations that ensure healthy competitive markets has been the best solution to economic problems. All you fools want to do is complain about others and cut some damn budget. You don’t offer corrective actions, just some puke to explain how all this economic crap is the fault of lazy people. Sounds like a pretty lazy excuse.

There’s no shortage of blame, lcr1946. Ignorance is not an excuse for the buyers who had to have learned ‘caveat emptor’ at some point. The lenders were misrepresenting themselves, looking to recap and make off with the federal subsidies. This would be perfectly ok if they made loans that were sound; fast-buck greed and federal pressure pushed loans onto poor credit risks.

The bottom line is still that the whole mess began with federal mandates to let people buy houses they couldn’t afford. The feds, after decades of public and private financial scandals, still do not know that Wall St. will paper ducks if saying ‘quack’ becomes popular. Or worse, they do know and use Wall St. to enable vote-buying, ultimately paid for by fleecing taxpayers.

Congress and Wall Street feed off of each other in an unholy alliance with gale-force winds created by the velocity of all the swinging doors between the two. They both feed on the American public.

No matter how you slice it, taxpayers end up footing the bill. Wall Street does more than okay, people who want something get it at the largesse of the government (certain politicians – taxpayers are invisible), politicians get votes and the taxpayer gets the bill. The only ones that had no part and no voice in the transaction are the ones who must pay. Does that seem right?

Most people who get government aide have little recognition that it’s anything other than magic money. Their politicians just sign bills or make policy in the vast void of government bureaucracies and stuff magically appears and nobody is hurt. Government transactions don’t have to be transparent about both sides of the transaction: who gets stuff without a bill and who gets the bill without stuff.

Democrats practice a group form of Munchausen Syndrome by Proxy. They exploit the needs of large groups of people making them dependent on Democratic power to control the resources of the nation (taxpayer dollars) to give them an ever expanding list of things they need or want, acting as though “the poor” are a homogenous group of victims who have been denied the chance to do good things for themselves. They also exploit the compassion of others in response to those highly exaggerated needs and demand reverence as compassionate guardians, caregivers and saviors. Intellectuals, professionals, and media sources are enlisted to give additional legitimacy to their claims. Program after program is demanded to combat the problems of “the poor” who rarely get better and, in fact, must not get better or the ruse breaks down. Munchausen Syndrome by Proxy is all about achieving power and control and is deemed abuse when done by individuals.

One example of how successful they are is the pervasive idea among Americans that there millions of starving children in America. There is abundant evidence of obesity in America, but where are the starving children? Yet the idea has been so successfully planted and exploited that most of us believe it in spite of what we know and see. There was recently a claim that millions of Americans were living on less than $2 a day. Where?

By the way, I have been among the very poor and know the very poor. Some are terrific, responsible people. Some are not. Just like any other group.

Searching for info on ‘the new housing bubble’, I stumbled on this article and read it with a mixture of alarm and growing interest. I can get in on the ground floor, woo-hoo!! FHA will finance with a credit score of 580 or better? I’ve got way better than that. Only 3.5% down.? Wow, I can afford a great new place You can get cash to fix up the home as part of the loan? A couple of jet skis in the driveway improves the whole neighborhood. You can claim income from a ‘roommate’ that will appear in the future? No problem, I can find a honey who wants to live in a nice place. If you can’t make the payments, there is a bailout program called HAMP? Are the application forms available on-line?

I’m underwater in my present house but I could rent it to my kids, maybe lease option till they accumulate their own 3.5%. Too bad its not an FHA loan so I could HAMP it. I’m going to retire and was thinking of WA state (no state income tax). Then I go to WA and buy a house with ten or twelve grand down, get some ‘fixup’ money to buy some toys. I would get a good rate with my good credit. Then I default and go with the HAMP program. I’d be golden.

Best thing is, when the bubble bursts I can feel like I have been victimized by the evil lenders and join the 47%. Poor old guy on a pension taken advantage of by the sharpies on Wall Street that got us into this mess in the first place. If the whole house of cards collapses again, I’m only a hop, skip, and a jump from Canada. Do I have to pay VAT on stuff I bring into the country even if its not paid for?